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Saturday, September 15, 2012

The Risks of borrowing money from 401K Plan

Money is the motivation for a
variety of actions. It is not uncommon for an individual to not completely
weigh the advantages and disadvantages of taking action in regards to earning,
borrowing and spending money. One action that people in a financial crisis have
decided to take during times of hardship is to borrow money from 401k. While
this may seem like a good idea for a short-term, there are many risks and
reasons to find an alternative solution to borrowing money from 401K.

Borrowing
money from 401k

A 401K plan is established to
support you financially after you retire from your primary occupation. Many
people forget about their financial future when faced with an urgent problem
that needs immediate action. The solution to this for approximately 15 million
individuals is to borrow money from 401k retirement plan. On the surface it
seems like the perfect solution because it is convenient, but you don’t need to
file any long applications or risk being turned down due to credit or financing
limitations. The interest rates that you do have to pay to borrow the funds
goes back into your 401k account, which means you are essentially not paying
any at all.

Loan Repayment

One of the primary downfalls of
borrowing money from 401k is that if you lose your job for any reason you must
pay back the loan within a very short time period of 60 days. If you are unable
to repay the full amount of the loan in that time frame it goes into default.
This poses a serious problem since it is possible for a loan to end up in a
default status as a result of unemployment.

Tax Penalties

If you do default on a 401k loan
you not only have less money to use when you retire, but the IRS views the
distribution as income and will require that you pay taxes on the amount that
was borrowed. This may cause you to pay additional taxes on your regular income
as well if you are bumped into a higher tax bracket. Unless you meet the age
requirement that is established and mandated on your 401k plan, you will be
subjected to paying taxes on the funds when it comes time to file your taxes
for the year.

Insurance

If you weigh the pros and cons and
still determine that your best financial move would be to borrow money from 401k,
there is a way to protect yourself from the potential risks. This protection
would come in the form of credit insurance offered by employers that would be
responsible for paying the loan if an event such as unemployment or disability
occurs. It is currently a way for borrowers to protect themselves with other
types of loans, but has not been extended to 401k loan. The primary
concern with insurance for 401k loan is how much companies should charge to
offer the service to borrowers. Many borrowers that are struggling financially
enough to borrow money from their best retirement funds may be hesitant to
purchase the insurance necessary to protect themselves.

Borrowers should keep the risks in mind when deciding
to tap into their treasured best retirement funds. Borrowing money from 401k
plan may not be as appealing as it originally appeared.

Byline

This article was written by Karl Stockton. He
believes it is better to take cash advance from
somewhere else than the 401k plan.